Company’s Stakeholders
Corporate governance may be defined as the system of internal controls, processes, and... Read More
A stakeholder is any individual or entity with a significant interest in a company. Corporations have a complex ecosystem that includes not only the shareholders but also other stakeholders. These groups mutually relate with the company for economic success.
However, the short- and long-term objectives of these conflicts may conflict.
Corporate governance practices tend to vary from country to country. However, it is not uncommon for different corporate governance systems to coexist within a country. Corporate governance systems generally reflect the influences of either shareholder theory or stakeholder theory or a convergence of the two. Current trends, however, point to an increase in convergence.
Shareholder theory posits that a company’s management’s most critical responsibility is to maximize shareholder returns. In other words, the interests of other stakeholders, such as creditors, employees, and society, are only considered if they affect shareholder value.
On the other hand, stakeholder theory emphasizes the need for a company to consider the needs of all its stakeholders. This theory dissuades a company from giving preferential treatment to its shareholders, at the expense of stakeholders such as customers, suppliers, creditors, employees, and essentially anyone interested in the company.
Consideration of ESG factors by the stakeholder theory comes with some setbacks:
The investors of a company include the bondholders and the shareholders.
The debtholders provide the company with debt financing. The debtholders consist of private debtholders and public debtholders (bondholders).
Private debtholders include banks, credit facilities, and institutions that provide loans and leases. They hold a company’s debt until maturity. Further, they can directly reach a company’s management and access non-public information concerning a company. As such, they significantly influence a company since they can be the largest source of capital. Therefore, they can lower debt restrictions and extend more credit.
On the other hand, public debtholders, including institutional investors and asset managers, depend on public information and credit rating agencies in their decision-making. In return for the capital provided, public debtholders receive regular interest payments and capital repayment at maturity.
Furthermore, public bondholders have minimal to no control over the issuing company’s operations and, therefore, depend on the terms outlined in the debt contract. However, they can play a significant role when the company faces financial distress, especially if the public debt needs to be restructured.
Public debtholders minimize downside risk thanks to their preference for operation stability and a company’s performance. This is usually in contrast to a company’s shareholders’ interests – tolerance of high risk for higher return potential.
Debtholders generally share the same perspective: lower financial leverage means lower risk. However, some private lenders may have varying risk appetites, behaviors, approaches, and relationships with the companies they finance. These lenders might focus on asset value, equity positions, cash flows, and business forecasts.
Led by the chief executive officer (CEO), managers are tasked to formulate and implement a company’s strategy. They do this under the stewardship of the board of directors. Additionally, they ensure the smooth running of a corporation’s day-to-day operations.
Managers tend to benefit when a company performs well. Conversely, they are adversely affected when a company’s financial position weakens. As such, they seek to maximize the value of their total remuneration while securing their jobs. Their interests are, therefore, not surprisingly different from those of shareholders, creditors, and other stakeholders.
The shareholders of a company elect the board of directors. It protects shareholders’ interests, provides strategic direction, and monitors company and management performance. Also, the board hires the CEO of the company.
The board usually consists of inside directors and independent directors. The inside directors comprise the company’s leading shareholders, founders, and senior managers. On the other hand, independent directors, as the name suggests, are not linked with the company concerning employment, ownership, and remuneration. As such, independent directors are elected because of their experience.
The board can have a single-tier or two-tier structure. In a single-tier board, the company’s board of directors includes executive directors (usually company executives) and non-executive directors (independent members without day-to-day involvement in company operations).
On the other hand, a two-tier board structure is a corporate governance model where a company’s board of directors is divided into two separate boards: the management board and the supervisory board:
Some companies have staggered boards. In these companies, directors are divided into groups and elected separately in consecutive years, resulting in a staggered rotation of board members. This approach creates a situation where it takes several years to replace the entire board.
The advantage of staggered boards is the continuity they provide to a company’s leadership. By preventing the simultaneous turnover of board members, there is a less frequent need for new directors to reassess strategy and oversight.
The downside of staggered boards is that they limit the ability of shareholders to effect a swift and major change of control at the company. With only a portion of the board up for re-election each year, shareholders may find it challenging to influence the board’s overall composition and direction on time.
An optimal board of directors does not exist. As such, boards vary based on the company’s size, structure, and type of operations. However, most governance codes stipulate that board members should reflect different expertise, backgrounds, and competencies.
A company relies on the knowledge and labor of its employees, or human capital, to deliver its goods and services. In return, workers often want competitive pay, room for advancement, steady employment, and a safe and comfortable work environment. Employees’ interests are better aligned with the company’s performance when they have the option to participate in equity-based incentive schemes in addition to their duties as employees.
Customers expect a company to satisfy their needs and give them the necessary benefits when they purchase its goods or services. Customers may receive continuous support, product guarantees, and after-sale service, depending on the products and services a company deals in.
Suppliers are the short-term creditors of a company whose main interest is to be paid as agreed for products or services delivered. Suppliers are interested in a company’s financial health and seek long-term relationships with it for mutual benefits.
Governments and regulators seek to ensure that companies comply with the law and act in a manner that safeguards the public’s interests and well-being. Moreover, governments collect taxes from companies.
Question
Which one of the following is least likely considered a primary function of the board of directors?
- Managing day-to-day operations of the company.
- Approving major corporate strategies and transactions.
- Overseeing the implementation of broad corporate policies.
Solution
The correct answer is A.
The board of directors is responsible for the governance of a company, including providing strategic direction and overseeing operations at a high level. However, it typically does not manage day-to-day operations.
That role is generally assigned to the company’s executive management team, led by the CEO or managing director. The board’s functions include overseeing the implementation of broad corporate policies and approving major strategies and transactions, ensuring that the company aligns with the goals and policies set forth for its successful operation.